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A finite-life private-information theory of unsecured consumer debt

  • Chatterjee, Satyajit
  • Corbae, Dean
  • Ríos-Rull, José-Víctor

We present a theory of unsecured consumer debt that does not rely on utility costs of default or on enforcement mechanisms that arise in repeated-interaction settings. The theory is based on private information about a person's type and on a person's incentive to signal his type to entities other than creditors. Specifically, debtors signal their low-risk status to insurers by avoiding default in credit markets. The signal is credible because in equilibrium people who repay are more likely to be the low-risk type and so receive better insurance terms. We explore two different mechanisms through which repayment behavior in the credit market can be positively correlated with low-risk status in the insurance market. Our theory is motivated in part by some facts regarding the role of credit scores in consumer credit and auto insurance markets.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 142 (2008)
Issue (Month): 1 (September)
Pages: 149-177

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Handle: RePEc:eee:jetheo:v:142:y:2008:i:1:p:149-177
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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  1. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  2. Bulow, J. & Rogoff, K., 1988. "Sovereign Debt: Is To Forgive To Forget?," Working papers 8813, Wisconsin Madison - Social Systems.
  3. Milgrom, Paul & Shannon, Chris, 1994. "Monotone Comparative Statics," Econometrica, Econometric Society, vol. 62(1), pages 157-80, January.
  4. Mailath, George J. & Samuelson, Larry, 2006. "Repeated Games and Reputations: Long-Run Relationships," OUP Catalogue, Oxford University Press, number 9780195300796, December.
  5. Hajime Miyazaki, 1977. "The Rat Race and Internal Labor Markets," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 394-418, Autumn.
  6. Hellwig, Martin, 1987. "Some recent developments in the theory of competition in markets with adverse selection ," European Economic Review, Elsevier, vol. 31(1-2), pages 319-325.
  7. Athey, Susan, 2002. "Monotone Comparative Statics Under Uncertainty," Scholarly Articles 3372263, Harvard University Department of Economics.
  8. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, Oxford University Press, vol. 90(4), pages 629-649.
  9. Susan Athey, 2002. "Monotone Comparative Statics under Uncertainty," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 187-223.
  10. Cole, Harold L & Kehoe, Patrick J, 1998. "Models of Sovereign Debt: Partial versus General Reputations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(1), pages 55-70, February.
  11. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
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